In an audit of the

Midtown

Corporation as of December 31,

2016,

the following situations exist. No entries have been made in the accounting records in relation to these items.

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Requirements

a. Define contingent liability.

b. Describe the audit procedures you would use to learn about each of the situations listed.

c. Describe the nature of the adjusting entries or disclosure, if any, you would make for each of these situations. (AICPA adapted.)

Question content area bottom

Part 1

Requirement a. Define contingent liability.

A contingent liability is

a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place.

Part 2

Requirement b. Describe the audit procedures you would use to learn about each of the situations listed.

Begin by identifying all of the audit procedures you would use to learn about situation 1. (Select the 4 choices that apply.)

A.

Analyze legal expense for the period under audit and review invoices and statements of legal counsel for indications of contingent liabilities.

B.

Review records for unusual journal entries made to the equity accounts (Common stock and Retained earnings) subsequent to year-end.

C.

Discuss, specifically, any related party transactions with management and include information in letter of representation.

D.

Obtain letters from all major attorneys performing legal services for the client as to the status of pending litigation or other contingent liabilities.

E.

Confirm details of stock transactions with registrar and transfer agent.

F.

Review financial statements of affiliate, and where related party transactions are apparent, make direct inquiries of affiliate management, and perhaps even examine records of affiliate if necessary.

G.

Discuss the existence and nature of possible contingent liabilities with management and obtain appropriate written representations.

H.

Review current and previous years' internal revenue agent reports for income tax settlements.

I.

Review the minutes of directors' and stockholders' meetings for indication of lawsuits or other contingencies.